Abe’s Next Move: Stoking a Mini-Boom

Peter Tasker

Peter Tasker

So it is five big wins in a row for Prime Minister Shinzo Abe. His solid victory in the October 22nd Lower House election puts him in a strong position to secure another term as head of the ruling Liberal Democratic Party next autumn.

If he continues in the job until 2021, as now seems likely, he will become Japan’s longest serving prime minister since the dawn of the parliamentary system in the 1880s.

Crucially for investors, this means an extended lease of life for the “Abenomics” reflationary policy regime under which the Nikkei Index has soared from an extraordinarily depressed level to a twenty two year high.

It is not yet known whether Bank of Japan Governor Haruhiko Kuroda is willing to serve another five year term himself. If not, it is highly probable that his successor will be a reflationist in the Kuroda mould. The nightmare scenario of a premature tightening of monetary and fiscal policy, bringing with it a resurgent yen and a return to deflation, is now far less likely.

Next on the Abe agenda is the necessary but politically contentious reform of Japan’s U.S.-imposed pacifist constitution, which has been treated as holy writ throughout the post-war era. On the numbers, he has a good chance of garnering the required two thirds majority in the two houses of parliament, but winning a simple majority in a national referendum -also required – is a trickier proposition. To maximize his chances, he will need the kind of public support that comes with a powerful “feel good” factor at street level.

That is not yet present. The Tokyo stock market is in maximum bullish mode and the BoJ’s tankan survey shows business confidence at the highest level since the last hurrah of the bubble economy in 1992. Yet consumers remain cautious. Indeed, the Economy Watchers Survey – which incorporates the views of hair-dressers, taxi-drivers and pachinko parlour operators, amongst others – peaked out just before the government hiked the consumption tax in 2014 and has gone nowhere since.

Fortunately for Abe there is every chance that, barring sudden squalls in the global economy, the next phase of his Abenomics project will deliver progressively better news to the household sector. The driver will be Japan’s structural labour shortage which is likely to intensify over the next few years, leading to higher wages and, ultimately, rising inflation. The combination of strong nominal GDP growth and super-low interest rates should prove increasingly stimulatory.

If Abe lets the economy run hot – and that means keeping fiscal policy loose too – there should be a mini-boom in 2020, just in time for the Olympics and the referendum on the constitution.

Labour shortages to restructure the Japanese economy

At first sight, such an outcome seems unlikely. After all, Japan is far from being alone in experiencing a long period of economic growth with quiescent inflation and little improvement in wages. Most of the developed world is in the same condition. Janet Yellen has described it as a conundrum and some economists have proclaimed the death of the Phillips Curve (which purports to establish a clear relationship between unemployment and inflation).

Yet just as ten years ago few would have predicted the current configuration of forces, so observers may be underestimating the potential for new factors to come to bear. First, the deflationary pressures of globalization are easing – Chinese unit labour costs in manufacturing are now practically on a par with Japan’s.. Second, the response function built into Western political systems suggests that more active fiscal policy and redistribution are on the way, regardless of ideological convictions. Thirdly, the pool of potential new entrants to labour markets is not infinite, especially if mass immigration is curtailed.

In Japan’s case, that last point is vitally important. Job growth has been strong under Abe, but most of it has been in the overwhelmingly female part-time sector, with some contribution from retirees going back to work on lower pay. However, the “part-time ratio” (the percentage of part-timers in the workforce) appears to have peaked already. The job-offer-to-applicant ratio for full-time employees (a standard measure of labour market tightness) has exceeded 1x for the first time ever. Japan is running out of non-working women and keen-to-contribute senior citizens. If business conditions remain buoyant, wages must rise.

Conventionally, labour shortages and rising wages are a threat to corporate margins and, eventually, economic health. In the case of Japan, however, the opposite may be true. As labour becomes scarcer and more expensive, managements will need to use it more productively. Ultimately, this will mean more investment in automation and more corporate restructuring and mergers and acquisitions.

In other words, some of the structural reforms that were supposed to be part of the “third arrow” of the Abenomics package will be implemented not by government fiat, but through organic economic processes. A quick glance at the structure of the Japanese banking system – and indeed at the inside of any bank branch, with its ranks of paper-shufflers – will demonstrate how much room there is for efficiency gains. Even the Bank of Japan agrees!

The performance of the construction sector, the first to suffer from severe labour shortages, demonstrates that, counter-intuitively, higher wages and higher margins can go hand in hand. Managements introduced innovative working methods and information technology to what had previously been a highly traditional industry and the result has been impressive productivity gains.

Pragmatism is the winner

What about fiscal policy? Abe fought the election on a platform that included a proposal to hike the consumption tax. Never a debt hawk himself, he may have felt pressured by his dip in popularity over the summer into offering something to other LDP factions. Now that his political position is secure, he can row back as much as he likes. The fact that the anti-tax hike Party of Hope, founded by Tokyo Governor Yuriko Koike, is now the third largest party, could provide the excuse. Abe could use Koike’s support on constitutional reform and scrapping the tax hike would be a sensible quid pro quo.

In Japan’s pragmatism-driven political culture, doing the opposite of what you once advocated is rarely blameworthy and often seen as sensible. In Britain, it is Jeremy Corbyn, the leftist leader of the Labour Party, who advocates the abolition of student tuition fees. In Japan, the conservative Shinzo Abe is not only proposing to offer free higher education, but wants to make it a constitutional right.

Fiscal largesse is a time-honoured element of mainstream LDP strategy and nobody would be surprised were Abe to revive it. Indeed, he has already made the case for the issue of “education” bonds that would be self-financing by generating higher incomes and thus tax revenues. Interestingly, the newly enfranchised eighteen and nineteen year old voters are the most pro-Abe age group of all, according to a Nikkei survey,

Does Abe have the stomach, quite literally, for another full-term in office? His first stint in power, in 2007, lasted just one year as health problems took their toll. Nine years as prime minister is a gruelling prospect, especially given Abe’s globe-trotting diplomatic schedule. Yet over the past five years, he has seemed to thrive on the challenges, making sure, for example, that he was the first foreign leader to meet with the victorious Donald Trump last November. Electoral success may be the elixir he needs.

In a world in which mainstream political parties are under the cosh, with even the previously invulnerable Angela Merkel damaged by the inroads of the populist Alternative For Deutschland, Japan’s political stability stands out like a beacon in a sea of fog. Abe’s electoral success is the product of his generally effective pro-growth policies. Four more years of the same should confirm Japan’s exit from deflation and return to the global stage as a major player.